MUMBAI: Bond Street is in a frenzy. Banks, funds and bond houses are buying gilts like they haven't for a long time, trading volumes have breached new highs, some are taking aggressive bets while those who sensed the party late are crashing in now. In the last few weeks, dealing rooms have been in the midst of an excitement not felt since the days of Lehman collapse. It's a market where the euphoria rarely boils over beyond pockets of Nariman Point, Bandra Kurla and Lower Parel where banks run their trading rooms.

If the price of a security goes up 65 paise, it's a big event, and unlike the ups and downs on Dalal Street, changing prices of faceless papers do not capture the imagination of retail investors. But few things impact households more than a bull run in a bond market: it's the single biggest indicator that interest rates are softening, debt mutual funds would fetch more, and home loan rates could be easier soon.

What has happened in the last week? "Bond market is a onetrick pony. The biggest influencing factor is inflation," said Sandeep Bagla, executive VP, ICICI Securities Primary Dealership.

What has changed is that a consensus is now building that the number will be below 5% for the year," Bagla said.

This week, the daily trading volume in government bonds crossed a record Rs 1 lakh crore. On one day, the combined volume in spot trades and interest rate swaps - deals cut to cover the risks from adverse interest rate movements - were at a striking distance from the total volume in the stock market. According to Bagla, there's headroom for yields to soften further as the inflation view "coupled with growth falling off is big for the market".

The 10-year government bond, which serves as a benchmark in the market, is trading at an yield (the effective return on a security) of 7.44%, down from 7.99% in early April. In the 'when issued market' — where trading takes place for securities that have not yet been issued — the yield on the new 10-year benchmark paper is quoting at 7.25%. This is unusual as it's the same rate at which the Reserve Bank of India lends money to banks under the repo facility. (Bond yields fall when demand for bond and prices rise) It may not be a bubble, but will it last? After two years of hardening rates and high inflation, traders have now spotted an opportunity to meet their full-year targets in one quarter and earn a higher bonus. While many foreign banks missed the rally and entered late, some institutions have become aggressive traders, booking profits on earlier purchases and buying fresh lots. "It will sustain for some time and may stabilise at current levels, but in the near future the pace of the market will depend on how RBI moves on rates," said Shashikant Rathi, head of debt capital market at Axis Bank, which has the largest proprietary trading book.

Indeed, if Governor Duvvuri Subbarao holds interest rates in June, there could be a sharp reversal, and some institutions will have to take a hit. But today few have such a hawkish stance. In fact, many think that with WPI averaging below 5%, it's difficult to conceive how the yield on the 10-year bond can remain above 7% for long. "Even though there is some irrationality, the market is finding a way to justify it as it hopes for a rate cut in June," says Pradeep Madhav, MD at STCI Primary Dealer, a leading bond house.

There are other drivers: mutual funds (which have no cost of capital like banks) are buying bonds, FIIs have stepped up investments after rules were simplified, and some banks and intermediaries — which have indulged in a bit of "arranger adventurism" by buying out debt issuance of corporates at lower-than-market yields — hoping to sell out later at a gain. The surge in demand is helping corporates to raise debt at fine rates. For instance, Power Grid Corporation has raised 9.5-year money at 7.93%, as against the usual floor of 8.5% for triple-A rated 10-year corporate bonds. Besides corporates, the biggest beneficiaries of the bond party (if it continues) would be public sector banks sitting on a mountain of bonds.